PTM062510 - Member benefits: pensions: drawdown pension rules immediately before 6 April 2015: guidance on all types of drawdown pensions (position immediately before 6 April 2015)
As of 6 April 2024 there is no longer lifetime allowance. If you are looking for information about protections, enhancement factors and the lifetime allowance charge please see these pages on The National Archives. If you are looking for information about the principles of lifetime allowance and benefit crystallisation events please see these pages of The National Archives.
Glossary PTM000001
Types of scheme that can pay a drawdown pension (position at 5 April 2015)
Different types of drawdown pension (position at 5 April 2015)
Amount of drawdown pension the member can take each year (position at 5 April 2015)
Receiving more than the maximum amount of capped drawdown pension (position at 5 April 2015)
Age when a drawdown pension can start (position at 5 April 2015)
Bringing a drawdown pension into payment (position at 5 April 2015)
Tax-free lump sum and drawdown pension (position at 5 April 2015)
Using part or all of the funds in a pension scheme to provide a drawdown pension (position at 5 April 2015)
Using part or all of the funds in a pension arrangement to provide a drawdown pension (position at 5 April 2015)
Testing against the lifetime allowance (position at 5 April 2015)
Taxation of drawdown pension (position at 5 April 2015)
Continuing to pay contributions into any pension scheme to build up extra pension once drawdown has started (position at 5 April 2015)
Transferring a drawdown pension in payment to another pension scheme (position at 5 April 2015)
Members drawing a scheme pension or who have purchased a lifetime annuity (position at 5 April 2015)
Note: Flexible drawdown funds in existence immediately before 6 April 2015 are from that date automatically treated as flexi-access drawdown funds, which have different rules.
Note: Capped drawdown that began on or before 5 April 2015 may continue, providing there have been no events since that date resulting in its conversion to flexi-access drawdown. But no new capped drawdown funds or flexible drawdown funds may be set up from 6 April 2015 onwards.
See page PTM062700 for guidance on flexi-access drawdown funds.
Types of scheme that can pay a drawdown pension (position at 5 April 2015)
Section 165, pension rule 4, Finance Act 2004
A drawdown pension can only be paid from other money purchase arrangements and cash balance arrangements. A defined benefits arrangement cannot pay a drawdown pension. A pension scheme does not have to pay pension in the form of a drawdown pension and many pension schemes do not offer this option.
Different types of drawdown pension (position at 5 April 2015)
Paragraph 4 schedule 28 Finance Act 2004
Subject to the rules of the pension scheme, a drawdown pension can be paid in either or both of 2 ways:
- income withdrawal
- a short-term annuity.
With income withdrawal, a pension is paid to the member directly from the funds in their pension scheme.
With a short-term annuity, the member uses some of their drawdown pension fund to buy an annuity contract from an insurer. This contract will pay a certain income each year for a fixed period of up to 5 years.
There are 2 types of income withdrawal:
- capped drawdown
- flexible drawdown.
A member can arrange, subject to what the rules of their scheme allow, for their drawdown pension to comprise a combination of a short-term annuity and either capped or flexible drawdown.
Amount of drawdown pension the member can take each year (position at 5 April 2015)
Section 165, pension rule 5, Finance Act 2004
There is no minimum amount of drawdown pension a member must take each year. This means that a member may designate funds for drawdown but not actually take any pension income from it if they do not want to.
The amount a member can take depends on whether the drawdown pension is taken as capped drawdown or flexible drawdown.
Where drawdown pension is taken as capped drawdown there is a limit on the amount of pension that can be taken each year from each pension arrangement providing capped drawdown pension. This limit applies to the total of payments taken as both income withdrawal and short-term annuities from the arrangement. PTM062530 explains what the maximum amount of capped drawdown pension is.
This limit does not apply to any pension arrangement providing flexible drawdown pension. In any year, a person can take as much pension as they like from a pension arrangement using flexible drawdown.
But flexible drawdown is only available if certain conditions are met.
Go to PTM062580 to find out more about flexible drawdown.
Receiving more than the maximum amount of capped drawdown pension (position at 5 April 2015)
Section 208 Finance Act 2004
If a member’s income withdrawals plus any short-term annuity payments for an arrangement come to more than their maximum drawdown pension for a pension year the amount over that limit is classed as an unauthorised payment. The member is charged to tax at a rate of 40% of the unauthorised payment. If the unauthorised payment is very large there may be an extra 15% tax surcharge. In addition to the member’s tax charges, the scheme administrator will have to pay a scheme sanction tax charge of at least 15% of the unauthorised payment.
Age when a drawdown pension can start (position at 5 April 2015)
Section 165, pension rules 1 and 6, Finance Act 2004
A member’s drawdown pension can start at the same time as any other authorised pension that member could begin to take from the registered pension scheme. Usually this is when the member reaches normal minimum pension age which is currently age 55. The normal minimum pension age will increase to age 57 from 6 April 2028. The pension can start earlier if a member either:
- meets the ill-health condition (see PTM062100)
- has a protected pension age which allows them to take their benefits at an age earlier than 55 (age 57 from 6 April 2028) (see PTM062200).
There is no upper age limit for starting a drawdown pension.
Bringing a drawdown pension into payment (position at 5 April 2015)
Paragraph 8 schedule 28 Finance Act 2004
The member starts a drawdown pension by ‘designating’ part or all of their pension funds to provide them with a drawdown pension. This means that the member tells their scheme administrator that they want to use a specific monetary amount to provide them with a drawdown pension. The funds that have been put aside (designated) to provide a drawdown pension form the member’s ‘drawdown pension fund’. The member’s drawdown pension will be paid from that drawdown pension fund.
Each pension scheme that offers drawdown will have its own processes for documenting how members designate benefits into drawdown pension.
Having designated funds into a drawdown pension fund, the member can then choose the amount and timing of the payment of their drawdown pension. They can choose to get regular payments or just draw funds when they want to. The member will need to agree this with their pension scheme which may have specific rules about how a drawdown pension can be paid.
Tax-free lump sum and drawdown pension (position at 5 April 2015)
A member may take a pension commencement lump sum in connection with drawdown (see PTM063200).
But there is no requirement to take a pension commencement lump sum. All the funds in an arrangement can be used to provide a drawdown pension.
Using part or all of the funds in a pension scheme to provide a drawdown pension (position at 5 April 2015)
Paragraph 8 schedule 28 Finance Act 2004
A member does not have to use all of their funds in a pension scheme to provide drawdown pension. Drawdown pension is provided at ‘arrangement level’ as opposed to ‘scheme level’. Each pension scheme can be a single arrangement or split into 2 or more pension arrangements. Generally, each arrangement can pay benefits separately from the other arrangements. This allows benefits to be taken in stages, at different times.
Traditionally, personal pension schemes have been split into many arrangements for one person allowing them to stage pension payments over a period of time. Occupational pension schemes have not tended to do this. But there is no reason why an occupational pension scheme cannot be designed to have lots of arrangements for each member. This is a matter for the employer and scheme trustees to decide when designing their pension scheme.
What this means is that funds can be designated in one arrangement to provide a drawdown pension, with funds left in other arrangements until a later date, all within the same scheme. A member can take drawdown pension from different arrangements under a pension scheme at different times.
A member will have one drawdown pension fund for each pension arrangement. If the ‘capped drawdown’ rules apply, the maximum amount of drawdown pension they can have is calculated for each arrangement.
Example
Chris is a member of a pension scheme where his benefits are split across 2 other money purchase arrangements - arrangement A and arrangement B. Each arrangement contains £200,000. He has not put any of his pension funds into payment and will take capped drawdown.
On 1 June 2011, Chris takes a pension commencement lump sum (PCLS) of £50,000 and designates £150,000 into drawdown pension in arrangement A. This creates a drawdown pension fund of £150,000. The scheme administrator works out that the maximum pension Chris can have each year from this pension drawdown fund is £7,650.
On 1 September 2011, Chris designates £100,000 into drawdown pension in arrangement B. He has chosen not to take a PCLS on this occasion. This creates a new pension drawdown fund of £100,000. The scheme administrator works out that the maximum pension Chris can have each year from this drawdown fund is £5,400.
Chris now has 2 drawdown pension funds under the scheme, being:
- £150,000 drawdown pension fund under arrangement A
- £100,000 drawdown pension fund under arrangement B.
The maximum annual pension Chris can be paid from arrangement A is £7,650. The maximum pension Chris can get each year from arrangement B is £5,400.
Using part or all of the funds in a pension arrangement to provide a drawdown pension (position at 5 April 2015)
Paragraph 8 schedule 28 Finance Act 2004
A member does not have to use all of the funds in a pension arrangement to provide a drawdown pension. If the scheme allows, the member can choose to designate only part of those funds to provide them with a drawdown pension. The member can add to their drawdown pension at any later time by designating extra funds from their arrangement into their drawdown pension fund.
Testing against the lifetime allowance (position at 5 April 2015)
Section 216 - BCE 1, 5A, 5B Finance Act 2004
A drawdown pension is tested against the member’s lifetime allowance when they put (designate) pension funds into their drawdown pension fund and are aged younger than 75 at that time.
Any funds in the member’s pension scheme that have not been put into payment (designated) or otherwise used to provide pension benefits (for example, by the purchase of an annuity) by the time the member is 75 will be tested against the lifetime allowance on their 75th birthday.
And any increase in the value of the member’s drawdown pension fund since the funds were originally designated will also be tested against their lifetime allowance on their 75th birthday. See PTM088650 for details of how to calculate this increase.
If the member designates pension funds into drawdown pension when they are 75 or over there is no test against the lifetime allowance because, as explained above, these funds will already have been tested (as uncrystallised funds) when they reached age 75.
See PTM080000 for more information about the lifetime allowance.
Taxation of drawdown pension (position at 5 April 2015)
Sections 579A to 579D and 683(3) Income Tax (Earnings and Pensions) Act 2003
The member is liable for Income Tax on any payment of drawdown pension they get. Whether the drawdown pension is being paid as capped drawdown or flexible drawdown, tax is due on any payments the member receives in a tax year. If the drawdown pension is being paid using a short-term annuity, the taxable amount is the amount due to be paid in the tax year under the terms of the contract, even if the member doesn’t get the payment in that tax year.
The pension scheme (or the insurer paying the short-term annuity) should deduct the Income Tax due using the PAYE system before making the payment to the member.
Continuing to pay contributions into any pension scheme to build up extra pension once drawdown has started (position at 5 April 2015)
Paragraph 14 schedule 28 Finance Act 2004
Contributions can be paid into the scheme providing the drawdown pension, or into another pension scheme. But if a member is considering taking their drawdown pension as flexible drawdown they will need to consider the tax consequences if they wish to continue making contributions (see PTM056510).
Transferring a drawdown pension in payment to another pension scheme (position at 5 April 2015)
Regulation 12 The Registered Pension Schemes (Transfer of Sums and Assets) Regulations - SI 2006/499
The transfer must be made to a new ‘empty’ pension arrangement.
The benefits from the new arrangement must be provided on a like-for-like basis. So, for example, if a member’s drawdown pension was being provided as a short-term annuity, after the transfer it must continue to be paid as a short-term annuity. If the transfer does not meet these conditions it will be an unauthorised payment. This means the member will have to pay a tax charge of 40% of the amount transferred. If the amount transferred is 25% or more of the value of the funds in the original pension scheme, the amount of the tax charge will be increased to 55% of the amount of the transfer. In addition to the tax charge, the transferring scheme administrator will have to pay a scheme sanction tax charge of at least 15% of the unauthorised payment.
Transferring the drawdown pension does not affect the maximum amount of drawdown pension that can be paid following the transfer.
Members drawing a scheme pension or who have purchased a lifetime annuity (position at 5 April 2015)
Paragraphs 7 and 8 schedule 28 Finance Act 2004
An existing scheme pension or lifetime annuity cannot be converted into drawdown pension.